Transfer Pricing: Internal pricing transactions with integrity
When a business sells products or services internally or to a subsidiary, the act of charging a usually lower price for this “controlled” transaction is known as transfer pricing. This is a common taxation and accounting practice among larger businesses such as multinational corporations or holding companies that use transfer pricing as a way to distribute its revenue before calculating its taxes or interest.
Because of the impact, it has on how much in taxes a business has to pay, transfer pricing is monitored closely by taxation authorities. Some businesses may be tempted to use transfer pricing as a way to evade taxes or reduce their tax burdens illegally, because of how it may be used to move funds to countries or jurisdictions with lower tax rates.
Business owners who are therefore looking to use transfer pricing must be aware of the relevant regulations as well as the risks involved to make sure that their transfer pricing methods are ethical and compliant.
Examples of cases where transfer pricing may be used include:
- Research projects carried out by a department for another department of the same company
- Transferring patents, royalties and other forms of intellectual property to subsidiaries
- A producer in one country selling its goods to a related party distributor in another country
Naming a transfer price.
Transfer pricing may be carried out in several ways following guidelines set by the Organisation for Economic Co-operation and Development (OECD), which are almost universally accepted by taxation authorities.
Many businesses often use transactional profit methods because these methods require less information but are less accurate, a result. These methods work by comparing the net operating profits from the controlled transaction to the profits of other businesses engaged in similar transactions. The two OECD-authorised transactional profit methods are:
- Transactional profit split
- Transaction net margin
Traditional transaction methods, on the other hand, are based on the terms and conditions of existing transactions between external or independent businesses. These methods work by comparing those terms and conditions with those of an internally controlled transaction. The three OECD-authorised traditional methods are:
- Cost plus
- Resale price
Transfer pricing in the Philippines.
Economic trends that are specific to the Philippines such as inbound remittances from overseas workers and the establishment of special economic zones have necessitated the development of transfer pricing regulations. These regulations took effect less than ten years ago, and have been updated recently by the BIR to include guidelines for conducting transfer pricing audits.
Note that Philippine authorities require businesses that use transfer pricing to validate their prices by submitting documents that include the details of the controlled transaction, cost contribution arrangements, and risk analyses. This validation process is not conducted annually but must take place whenever a transfer pricing transaction is carried out.